Probably self-employed people know it the best - running your own business comes with many advantages like being your own boss and having the freedom to make any decision. But, business situations also demand you to handle everything on your own. And one such responsibility is paying your own taxes!
We get it, business owners have so much on their plate that filing taxes on their own can become an overwhelming process. But, regardless of how you feel about managing accounts, there’s no way out of it. So, if you are running a business in the UK, it’s important to understand all the tax obligations to avoid any kind of penalties or fines.
So, let's make this easy! Today, we will look up all those aspects of taxes such as - what taxes you need to pay, the possible deductions that you can get from it and how to file your own taxes in the UK.
What is self-employment tax?
Before we jump to the specifics of filing taxes, we want to make sure you understand the distinction between self-employment and employment.
While this may sound silly, there can be situations when your status can be hard to define.
In such cases, you are expected to show your self-employed earnings separately and instantly inform HMRC if you choose to opt for a status of a self-employed individual. It's also important to keep up with the tax guidelines and deadlines.
This means that if you are running a self-employed business, then you are the sole responsible person to pay taxes - unless you have a professional alongside. So, make sure you are paying all the taxes on time.
Now let's talk about taxes!
As a self-employed person, you must pay a share of your earnings in the form of income tax and National Insurance Contributions (NIC).
Income tax is calculated on your earnings after you have taken away any allowable expenses. In simple terms, allowable expenses are costs that are directly related to your business. These can be a one-off payment or regular costs like your office rent, equipment or travel expenses are your allowable expenses.
The next type of tax that you need to keep a check on is NIC. These can be a bit more complicated - but of course possible to understand! NICs are of two types that you need to pay as a self-employed person.
- Class 2
- Class 4
It’s worth noting that NICs are based on your earnings.
These taxes and procedures may seem like a lot of numbers to track at this point, but don't worry - we have got a detailed guide that highlights everything in detail. So, even if you have just started your business journey - we'll help you streamline this process!
Reporting self-employed taxes
For starters, in order to gain a self-employed status, you register with HMRC. It will lead you to get a Unique Taxpayer Reference (UTR through which you can create an online account with HMRC.
Amid this, make sure you are recording your financial aspects, cashflows, invoices and sales. You will be doing this for the entire tax year.
Next, file out a self-assessment tax return form by tax year-end. It lets you show your annual income, expenses any additional sources of income that you have.
The deadline for tax returns and paying taxes is 31st January (following the end of the tax year).
What are the different kinds of self-employed businesses?
- Freelancers: Working as a freelancer in the UK means that you provide your own unique products or services in the market. You will be usually working with your own clients on a project basis. Freelancers who offer their services will need to pay taxes and National Insurance contributions to the government. You may further need to register for VAT if your earnings exceed the limit set by the government.
- Sole traders: This is one of the common ways of running a self-employed business. Usually, sole traders run their own businesses as an individual - typically here you will be managing your business and its finances on your own. But here's the deal of being a sole trader- your personal and business assets are not separate and so, you will enjoy all profits and also bear all losses. It's crucial to understand that being a sole trader does not mean that you need to invest in a shop, be a shopkeeper or own a tangible product. You can also work as a hairstylist or maybe a writer to fulfil the norms of being self-employed. Being a "business' is just the official term used to describe your self-employment.
- Contractors: Contractors are people who work on a temporary basis on a specific project or contract. They work under certain timelines and are expected to get the work done within that timeline itself. Contractors can work in a number of industries like construction, IT and engineering. In such situations as well, you will be paying the NIC and income tax.
- Partnership: This is another common way to run a business. Here, two or more people share profits and losses and it can take many forms, including limited liability partnerships (LLPs). The partners need to pay their taxes individually and are responsible to keep a track of all the profits they have during the year.
- Limited companies: A limited company is known as a separate entity from its owners. This means that your limited company has its own tax liability. Here the owners of limited companies are not personally responsible for the company’s debts. Limited companies are run by shareholders - they can either be directors or non-executive directors. If you are running a limited company, ensure that you are filing annual accounts and tax returns with Companies House and HMRC.
Taxes that self-employed individuals pay in the UK
Filing taxes as a self-employed individual can be a breeze if you are prepared for the UK's tax season! While the UK government is quite strict about its tax regulations, the authorities have made sure to make this process as smooth as possible.
Talking about taxes, self-employed business owners pay two types of main taxes - Income Tax and National Insurance contributions.
Income tax - self-employed
Sometimes, self-employed people believe that they must pay income tax on their full income, but this is not the case! However, they only contribute a portion of their trading profits towards income tax.
If you want to predict the amount you pay towards tax, you will have to calculate your trading profits. Once you have your trading profits in place, you can subtract your business expenses from your total income.
And this is it - the calculated amount is the one that you pay towards your taxes.
The taxes that you pay depends on your business size and your yearly earnings. Here's a simple breakdown to understand this more clearly
- Personal allowance: 0%
£0 to £12,570 - here you don't have to pay income tax on your profits
- Basic rate: 20%
£12,571-£50,270 - here you will be paying 20% tax on your profits
- Higher rate: 40%
£50,001-£150,000 - here you will be paying a 40% tax on your profits
- Additional rate: 45%
Over £150,000 - here you will be paying 45% tax on your profits
For example, you earn £55,000 a year. Then in this situation, you will pay 20% income tax on the first £37,500 of your trading profits, and 40% will be out of your pocket on the remaining £4,730.
So, make sure that you are well aware of tax regulations from the government’s website. If you are confused about anything, get assistance from HMRC for help and guidance.
National Insurance Contributions - self-employed
If you are self-employed and earning more than or equal to £6,725 (2023-24 tax year) every year, then you will pay Class 2 NICs. It comes with a pretty simple flat rate of £3.05 per week.
If this amount goes beyond the threshold, then you are expected to pay £3.15 a week or £163.80 a year.
Class 4 contributions are calculated as a percentage of your profits and you will be paying them when your profits go beyond £12,570 per year. Currently, self-employed individuals are paying 9% on profits between £12,570 and £50,270, and 2% on profits over £50,270 for Class 4 contributions.
Here's something to bear in mind: you will not be eligible for small profits exemption for Class 2 contributions if you are making small profits below £6,725 / year. And if you qualify, then you do not need to pay Class 2 contributions. However, you can still claim benefits that are dependent on National Insurance contributions.
In simple terms, if you are voluntarily paying class 2 contributions, even if your profits are lower - it can help you build contributory entitlements to benefits and state pensions. So, it's smart to stay on top of your NICs and best to pay an accurate amount to seek the best benefits available.
Usually, you will be paying your NICs annually as a part of your self-assessment tax return. The amount for NIC is calculated by HMRC - this is calculated based on the details you provide in your tax return.
Besides paying income tax and National Insurance, there are chances that you may need to file other taxes to the government. This will depend on your company's operations. For example, you may be required to pay VAT if your goods and services are subject to VAT.
Self-assessment tax bill
Initially, when you work for yourself with limited resources, you become your own accountant and tax specialist. We have all been there!
But, amidst this, there are chances that you lose track of your finances along the way and may overspend your tax money. It's recommended that you prepare for your self-assessment - it will estimate the tax money you will owe at the end of the tax year.
Self-assessment tax bills can come in handy to avoid any unpleasant surprises and help you to remember the taxes that you need to pay to the government.
Typically, you pay tax and NIC on your self-employed earnings in arrears. Any tax that you owe in the 2021/2022 tax year is not due until January 2023. So, with the self-assessment tax bill, you will have 9 months to prepare how much amount you will be paying for taxes.
How to pay taxes as a self-employed individual
When you’re self-employed, it's your responsibility to keep track of your income, expenses, and taxes. You must follow a procedure to become a self-employed person with HMRC. Here are things you should know:
- Sign up with HMRC: So, the first step after going independent is to register for self-assessment with HMRC. You will be setting up an online account and making sure to submit a tax return every year.
- Keep accurate records: Be sure of maintaining all your company's documents including invoices, bank statements and receipts. Your tax process becomes much simpler and more organised if you do so.
- Know your deadlines: This is one thing that can save you from penalties and uncalled expenses. So, when you are filing taxes, you need to make sure that you know the tax deadlines - which run from 6 April to 5th April of the following year. The deadlines for submitting your returns and paying due taxes are 31st October and 31st January respectively.
- Pay your taxes: Filing your returns means that you need to pay taxes on time as well. You can pay your taxes in different ways such as by bank transfer, post or online.
- Consider making payments: If you owe more than £1,000 in yearly taxes, you might want to consider making payments on the account as soon as possible. This means paying an estimated amount of tax in advance, which is then offset against your final tax bill.
Here's a heads up again - never forget to pay your taxes or take it leniently. It is crucial to stay on top of your records and accounts to fulfil all of your tax deadlines. And, if you're unsure about anything, seek advice from an accountant or tax specialist.
How to reduce taxes if you’re self-employed
As a self-employed individual, you can try using some ways to reduce your income tax bill:
- Claim business expenses: These expenses are something that keeps your business up and running. Some of these include travel costs, office rent, equipment and other professional services. You can claim these expenses and try reducing your taxable profits.
- Claim capital allowances: Capital allowances like machinery and equipment, business assets etc can also be used to deduct a percentage of your entire tax.
- Contributing to a personal pension scheme can enable you to reduce your tax bill to an extent.
- Use tax-free allowances: Use tax-free allowances wisely, such as Personal Allowance and Dividend Allowances.
- Timing your income: This is something that not a lot of people know about. You can consider timing your income so that you receive it in the tax year when your profits are likely to be lower. This can keep your taxable income below the higher tax limit.
- Get a professional onboard: Consulting an accounting or tax professional can ease up your life 10x times. They can help you in identifying additional tax savings and opportunities where you can save your money.
Other types of tax – VAT
In certain situations, you may also have to register for Value Added Tax. So, when your business has an annual turnover of more than £85,000, then your business becomes eligible for VAT as well. VAT is a value added to goods and services and you usually pay this to HMRC.
Note that, you will further need to keep digital tax records and submit VAT returns using HMRC's Making Tax Digital System.
But here's something worth noting- Some businesses that come below the VAT threshold still register for VAT as there are certain benefits involved in doing so.
Additionally, there are some VAT schemes available that can make things easier for small businesses. For example, the Flat Rate Scheme allows you to pay a fixed rate of VAT based on your business type.
It's important to keep accurate records of your VAT transactions and submit your VAT returns on time to avoid any penalties or interest charges.
We hope this guide has made it easier for you to file your own taxes in the UK. If you wish to make things simpler, you can open a wamo business account with us and get started right away.
While opening a business bank account with a traditional bank can take more time and money than you want to spend - opening a business account with wamo is fast and easy and you can do it online from anywhere.
As a financial management service provider and a payments platform in one, wamo is much more than an app and operates differently from the traditional banks you know. Our features and services are tailored for small businesses and independent individuals like yours to manage all your financial aspects. We further believe in the power of human-centred support and enable you to get instant help from our experts. So, if you plan on doing your own taxes, wamo can be a great option to explore.